How To Prepare an Annual Budget for a Company

By Indeed Editorial Team

Updated March 8, 2021 | Published September 25, 2020

Updated March 8, 2021

Published September 25, 2020

The Indeed Editorial Team comprises a diverse and talented team of writers, researchers and subject matter experts equipped with Indeed's data and insights to deliver useful tips to help guide your career journey.

A carefully planned annual budget allows you to continually track the financial health of a business. When you understand the obligations and opportunities of a business, you can set better priorities and objectives, make long-term commitments to clients and vendors, and make better hiring decisions. Reviewing tips for preparing an annual budget can help you prepare one for yourself more easily.

In this article, we discuss why annual budgets are important, the steps to take to prepare a budget and additional tips for how to create an annual budget.

Why annual budgets are important

An annual budget is important because it allows businesses to set priorities, goals and spending caps. It allows the business to track where it is financially, which allows for more effective long-term planning. Creating an annual budget also helps you recognize when you have the ability to hire new employees, set new earning goals in line with company objectives and invest in new profit lines. Other benefits for creating an annual budget include:

  • The ability to open lines of credit

  • Simplify tax preparation

  • The ability to make educated decisions about overhead expenses, salaries, benefits and bonuses

Related: What Are Budgeting Processes (Plus, How To Develop Your Own)

How to prepare an annual budget for a company

Preparing an annual budget can help you increase profitability and ensure you will have enough capital to keep the business running throughout the duration of the year. Here are the steps you can take to make an annual budget:

Related: Budgeting Template Types for Financial Success

1. Review profit and loss statements

To begin the process of creating an annual budget, start by examining the profit and loss statements from the past two years. Remove unusual expenses that you don't anticipate during the coming year, as well as one-time revenue.

Average the numbers from the two years of profit and loss statements and then adjust them for the expenses that went up during the course of the year. Also make any modifications for changes in gross margins, one-time investments, market conditions and revenue that you anticipate during the coming year. Also take into consideration how changes in some areas might impact others. For example, if you hire more sales professionals, your revenue should go up from the additional sales, but you also will spend more on health insurance and other related costs.

Related: Forecast vs. Budget: Differences and Steps To Forecast Budget

2. Take a closer look at expenses

Once you have a general idea of what your company's revenue and expenses will be for the year, you should take a closer look at expenses. Some of your company's expenses are fixed costs like insurance, rent, leases and other services that you regularly use. This is a good time to consider taking a closer look at the rates you're paying to see if you could get better rates on insurance or other services.

You should also take a look at employee compensation since it should be in line with company growth and revenue. You should also take a look at whether you will need to hire, the impact hiring will have on other areas of your budget and what level of experience you need that person to have to optimize operations.

3. Examine capital expenditures

Capital expenditures like new computers, machinery, furniture and other items are also important to include in the budget. If you are hiring new employees, for example, they will need computers and other items to successfully do their jobs. Think through what equipment you will need to purchase for new employees. Also think about any equipment you will need to purchase or update to produce your product or service. Keep in mind how the investment can impact output. While it can be tempting to put off large investments, this decision can impact delivery timing, quality of product and output, which can have a big impact on revenue over time.

Read more: Capital Budgeting: Definition, Importance and Different Methods

4. Calculate your cash flow

When you're creating your annual budget, it's important to keep cash flow income. For example, you may need to buy inventory before making sales and you need to ensure you have the cash on hand to make the necessary purchases. In cases like these, you can create a cash flow statement using your income statement and AR/P turnover rates.

5. Put the budget in your finance system

You can divide your annual budget by the 12 months of the year and then use it to evaluate your monthly revenue and expenditures. Every time you review your financial statements for the month, compare them to the budget and gain a better sense of how close your projections were. This can help you keep expenses in check while also helping you create a more accurate annual budget in the future.

Tips for preparing an annual budget

Here are some additional tips you can use to prepare an annual budget for a company:

  • Consult with other departments: It's a good idea to consult with other departments in the company to get insight and feedback for the coming year. For example, the sales team can help you set realistic expectations for sales revenue, the manufacturing team can provide insight on large purchases for updating machinery or other manufacturing expenditures and the research and development team can help you prepare for new product releases and costs to anticipate as a result. Getting feedback from all departments in the company can help you create a more accurate and effective annual budget.

  • Ask yourself if the budget is realistic: Think through your revenue goals and why you set the numbers you did. For example, what investments are you making that will lead to an increase in sales revenue? Sometimes when creating a budget, revenue is projected too high and expenses are projected too low. If you aren't sure whether your financial projections are accurate, consider increasing your expenses by 10% and reducing revenue by 25%. This can guard against unexpected cash flow shortages because you underestimated costs and overestimated profits.

  • Begin early: Creating an annual budget takes time, especially if you are consulting with other departments. It's generally a good idea to begin creating your budget by October to give yourself plenty of time to get a detailed estimate of your projected revenue and expenses. This also gives you plenty of time to begin making preparations to hire new employees in the coming year if you budget for new positions.

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